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Managing Cash in a Networked Economy

How to combine payment term standardization with an early-payment discount program to manage cash better.

As more and more trading partners leverage business networks to manage invoices and payments, a term has emerged to describe the phenomenon: “the networked economy.” In most cases, discussions about the networked economy have involved movers and shakers in procurement and finance. In too many companies, the conversation has left out an important stakeholder: the treasurer.

Why should a corporate treasurer be interested in an e-commerce initiative? That could be a $100 million question. Treasury policies focused on static discounts and maximizing float can undermine business performance. Savvy treasurers who can translate today’s collaborative procure-to-pay approaches into better cash and working capital management have the opportunity to drive new strategies that increase profitability and cash returns.

New Approach to Managing Cash

One area of low-hanging fruit for many treasury teams is early-payment discounts from suppliers. As increasing numbers of buyers and suppliers settle transactions over digital business networks instead of on paper and by mail, the pace of commerce accelerates. Invoices can be approved and scheduled for payment in days, which gives treasurers a new opportunity to manage cash better. They can capture more early-payment discounts for risk-free, double-digit cash returns.

For organizations looking to increase their returns on cash in the current low-interest-rate environment, there’s arguably no better option than to seek out early-payment discounts from suppliers. The treasury, procurement, and finance functions can work together to set a hurdle rate, the minimum rate of return the company is willing to accept in exchange for paying early. Then they can define the amount of cash the company is willing to use to obtain these discounts and identify which suppliers or supplier groups to include in the program. Although some may be concerned about the negative impact that early-payment discounts may have on days payables outstanding (DPO) and working capital, a treasury team that pays close attention to payment terms can have the best of both worlds.

Payment terms sometimes seem like the neglected stepchild of corporate finance. Too often, an assortment of diverse payment terms proliferates as buyers negotiate contracts with suppliers without following a predefined strategy. For an organization with a team of buyers and thousands of suppliers, it’s not uncommon to have more than 100 distinct sets of payment terms, and the list often includes oddball terms such as net-7-day or net-15-day terms with no early-payment option.

The inability to get payment terms under control can contribute to worsening DPO metrics. As an example, the average DPO at one energy company we worked with fell over a three-year period from more than 50 days to less than 30 days, a level well below the norm for its industry. When the company realized how its DPO had moved, it supported a payment terms–extension program. The company closely examined its payment terms and worked on extending those terms with many suppliers that it was paying faster than the standard in the industry.

For many organizations where terms extension is practical, choosing and applying a handful of industry standard payment terms, supported by early-payment discounts, can have a dramatic impact on cash earnings and working capital. A certain segment of spend—such as utilities, telecommunications, taxes, property leases, and charitable contributions—will always be exempt from consideration. Likewise, key suppliers accustomed to being paid in less than 30 days may not be willing to negotiate either terms extensions or early-payment discounts.

Still, about two-thirds of a company’s total spend, on average, should be ripe for a program that involves some combination of terms extension and early-payment discounts. How an organization decides to match payment term offers to different suppliers will depend on several variables, including commodity category, vendor size, potential risk to the business, ease of collaboration, whether it is a mission-critical partner, and cash-flow demands. Reliable transaction data from a business network can prove to be a great asset in this analysis.

Attention to Payment Options

When approaching suppliers to negotiate or re-negotiate payment terms, a company may want to offer a choice of payment options that could include supply chain financing and p-cards, along with early-payment discounts, and tie these into a check-to-ACH conversion project.

Supply chain financing would be reserved for large, strategic suppliers that could work with the buyer’s bank on receivables financing to leverage the supplier's lower cost of capital. Take the case of an overseas vendor that stocks critical parts for a U.S. manufacturer. If the manufacturer requires the vendor to maintain a minimum inventory level to fill orders on demand, supply chain financing would be a good option to finance that inventory.

On the other end of the spectrum, for transactions in the range of $5,000 or less, companies may want to offer a p-card program to card-accepting suppliers. An organization’s p-card purchases may be extensive, but they’re unlikely to represent a large proportion of the company’s total procurement. For example, you may use p-cards with 80 percent of your total suppliers, but p-card purchases may represent only 20 percent of your total spend.

Meanwhile, converting payments from paper checks to an electronic format such as ACH makes sense for payments that aren’t a good fit for supply chain financing or for p-cards. Compared with paper checks, ACH payments offer lower costs and some protection against fraud for buyers, while helping suppliers decrease days sales outstanding (DSO). Any accounts payable group that is cutting paper checks daily, or even several days a week, should consider reducing paper check runs to once a week. This will motivate more suppliers to accept ACH payments.

New Potential in Dynamic Discounts

That brings us to one more option for those exploring new payment terms with their suppliers: dynamic discounting. Traditional discounts, such as 2 percent 10-net-30 are static—on day 11, no discount exists, so the buyer has no incentive to pay before day 30. In contrast, dynamic discount opportunities continue on a sliding scale up to the due date of the invoice.

With dynamic discounts, a company can capture standard discounts, as it normally would, but also take advantage of additional discount opportunities from the purchase date up to the net term of the invoice. These may include both smaller discounts (on the sliding scale) for payments received after the standard discount deadline and discounts at a higher face-value rate for payments received before the standard deadline. Discounts can be captured at any time of the month or year, but they tend to spike upward at the end of the fiscal quarter or fiscal year. Suppliers often have higher demand for cash at these times, so they are more willing to accept discount offers in exchange for immediate payment.

Businesses that combine dynamic discounting with electronic invoicing usually get up and running with an early-payment discount program before the e-invoicing or dynamic-discount solution is in place. This “rapid ramp” approach targets suppliers that either have offered discounts in the past or have never been approached with the idea of early-payment discounting. For suppliers that agree to participate, the buyer initially assigns a mutually agreed-upon standard payment term and captures the discounts manually. Once the e-invoicing and dynamic discounting software are in place, those solutions handle the discounts automatically, and they can expand to include the sliding-scale discounts. One oil and gas company that followed this approach identified nearly $1 million in savings through early-payment discounts in three weeks.

For many suppliers considering p-card payments, dynamic discounts may be a better option. Their flexibility is a major advantage. P-card merchants have fixed fees, and suppliers have no leverage to negotiate the rates. They can, however, counter a buyer’s discount offers as part of a negotiation over accelerated payment. Plus, the cost to accelerate payments is well below p-card rates.

Another factor to consider is that suppliers in certain industries may be more likely to embrace discount programs. In retail, for example, the factoring of receivables is a common practice for supporting a supplier’s cash flow needs. Dynamic discounting can serve as an appealing alternative, where the cost to the supplier of accelerating payment is typically lower than the financing charges of a factoring firm.

Boon to Working Capital

When a business follows a best-practice approach to dynamic discounting, it can expect 20 to 25 percent of targeted suppliers will opt for discounts. Top performers can save $2 million to $3 million in early-payment discounts for every $1 billion of targeted spend and earn 24.6 percent annualized cash returns on average, typically higher than p-card rebates. There’s also the considerable working capital impact of a program that extends payment terms, which can free up about $3 million in cash for every $1 billion per day of DPO improvement.

For companies that combine a payment-term extension program with pursuit of early-payment discounts, the net result is win-win. The buyer can help many of its suppliers get paid sooner, but at the same time it’s capturing some early-payment discounts, it’s also freeing up valuable working capital by extending payments for suppliers that don’t accept the discount. For an organization with $4 billion of spend and an average four-day DPO extension across 60 percent of that spend, that’s nearly $28.8 million in freed-up working capital. Extend DPO by 15 days—going from 30- to 45-day standard terms—and, well, you do the math.

What’s holding your company back? With interest rates at historic lows and many suppliers strapped for cash, the time is right to take a closer look at how your organization is managing cash and working capital. If your income statement shows healthy margins, sizable cash balances, and little debt, there could be no better strategy to improve bottom-line results.

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Chris Rauenis a solutions marketing manager for Ariba, an SAP company. In this role, he is responsible for marketing programs that educate finance, procurement, supply chain, and other business professionals on the transformational potential of the Ariba Network and Ariba’s cloud-based financial solutions. Before joining Ariba, Chris spent more than 15 years in business-to-business marketing for technology innovators OpenVision, Documentum, and Xign Corporation.

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